PROJECT M
 
Andreas Gruber
Rajeev Mittal
Wouter Pietersma

Conference Call: Wedded for the very long run

Long-term investments are beset by a multitude of challenges ranging from long-term inflation risk to transparent regulations. And, not least of all, a crucial human element is involved

Conference Call: Wedded for the very long run

Long-term investments are beset by a multitude of challenges ranging from long-term inflation risk to transparent regulations. And, not least of all, a crucial human element is involved


Andreas Gruber

As you know, the notion of long-term investing ranges from five to 30 years or more. In the case of our life insurance portfolios, we are looking at investment spans of 10 or more years, with a focus on diversified, valuation-based strategies. Diversification reduces the so-called specific risk of single assets while keeping overall market risk. To mitigate this, we diversify not only single investments, but also whole investment strategies.

For example, we like infrastructure investments, debt and equities, where returns usually are less correlated to public market developments. Returns often are inflation adjusted, which is not usually the case with public market investments. For our property and casualty portfolios, the investment horizon is three to five years.

Wouter Pietersma

Frankly, to me, long-term ventures almost resemble a marriage. As a government official working on infrastructure projects and public-private partnerships (PPP) over 20- to 30-year time horizons, I have learned not to fight and argue over little things.

As the term “partnership” indicates, one needs to be flexible to accommodate both sides to make it last.

Rajeev Mittal

A definition really comes down to the investor’s profile. A pension fund or an insurer with liabilities stretching out over 30 years has a different mindset than a day trader.

Ultimately, however, the objective is the same: how can we generate returns while mitigating losses? Before the financial crisis, investors typically maintained long-term strategies almost irrespective of market outlooks. They often believed that over a long period of time, peaks and valleys would even out. This belief – or, rather, illusion – was shattered by the crisis. Today, we believe institutions should take a more intermediate view, that is, nine to 18 months.

Andreas Gruber

I think market developments have led to short-term strategies by investors and more pro-cyclical behavior. Solvency II and capital requirements force investors to create sufficient buffers. They allow institutional investors to take more risk in a rising market when unrealized gains increase. In a deteriorating market, portfolios lose value, buffers vanish and investors are forced to sell. This puts more pressure on the market and reinforces downturn trends, eventually leading to increased volatility.

Rajeev Mittal

Increased regulations and capital requirements clearly affect investor behavior. At the same time, that also creates opportunities as one set of investors exits asset classes and a new one enters.

Wouter Pietersma

Well, regulation can’t be ignored, but it has to take the interests of both sides into account. PPPs are partnerships, and risks should be borne by the public or private entity that is best able to carry that risk. Some risks – and their consequences – are too large and should stay on the government side. But regulation also has the potential to increase risk for investors, thus discouraging them from infrastructure investments Governments should have a clear objective to reduce regulatory complexity. Standardization of design, build, finance and maintain contracts also helps.

Andreas Gruber

The positive side of regulation, such as Solvency II, is that investors are forced to think more ahead.

Wouter Pietersma

I agree. We are currently looking at a time horizon of 30 years, while seeking private financing to rebuild a sea lock with total costs of €880 million ($1.1 billion) in the port of Amsterdam. The contract will be design, build, finance and maintain, allowing for a four-year realization and a 26-year maintenance phase. The investment will be repaid by the national government with availability payments once the project is finalized in 2019.

Andreas Gruber

This perfectly fits the investment targets of our life portfolios.

Wouter Pietersma

Right. And it delivers value for money, timely completion and more efficient maintenance for us. The investor has to maintain the structure efficiently if he wants to make a profit, as government payments are capped and based on a performance regime for availability.

Rajeev Mittal

In the current low-yield environment, infrastructure investment has gained traction for many insurers and pension funds as they offer both yield and stable income. Still, investors may not be able to completely fill the gap.

Wouter Pietersma

On the government side, we need to reduce complexity, and the project management needs to be insulated against political pressure. That is one of the reasons why, in the Netherlands, project execution is governed by an executive agency more independent of our minister.

Andreas Gruber

We would really like to invest more in infrastructure, but appropriate projects are hard to find. Countries with stable regulation offer only a few up to now, with one exception: the UK.

Infrastructure investments in developing countries often involve too much uncertainty. As investors, we are comfortable dealing with risk because it is a variety of outcomes that are subject to a specific, more-or-less known probability distribution function. It is our key expertise to assess and price possible outcomes.

But without stable regulation, one acts in uncertainty, meaning the probabilities of different outcomes cannot be calculated. In this case, reliable valuation of long-term investments is impossible.

Wouter Pietersma

Still, I see a lot of potential for public-private partnerships in Europe, with an increasing role for institutional investors on the financing side.

The pilot phase of EU project bonds, with risk guarantees by the European Investment Bank, can make infrastructure investments more attractive to insurers and pension funds. The bonds enhance companies’ credibility through the EIB’s first loss risk guarantees.

But whether or not they lower inflation risk remains to be seen. However, I’d be interested to hear more about the nature of your liabilities, Andreas.

Andreas Gruber

They are twofold: long-term to deliver old-age provisions for our life insurance clients, and short-term in the field of property and casualty. For both, we create a strategic asset allocation based on liability modeling and independent of market expectations.

To arrive at actual asset allocations, we take potential long-term market developments but also tactical portfolio allocations into account. The result is a portfolio of more than 50 different investment strategies.

Wouter Pietersma

It has been stated that the new European Commission would like to mobilize €300 billion ($380 billion) of public and private investments, in infrastructure as well as other areas. And private investors are essential to that. That policy will help to attract and facilitate private investments.

Andreas Gruber

I agree. For example, the German government started an initiative to improve infrastructure and to increase investments by private investors. This is good news. On another point: it has been said that long-term investments are more predictable than short-term, and I think there is some truth in this.

Rajeev Mittal

Frankly, I don’t agree. Even over the long term, investment performance can be unpredictable. However, we do believe it does take 12 to 18 months before markets catch up to fundamentals.

Andreas Gruber

Well, take quantitative easing, for example: Nobody really knows when the Fed will start increasing interest rates. But one can be pretty sure the Fed will have increased interest rates two years from now.

So in my view, it is much easier to predict something in the long term because there is less noise and less volatility.

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